indian govenment policy towards forex markets

34
A Project on INDIAN GOVERNMENT POLICY TOWARDS FOREX MARKETS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE DEGREE OF MASTER’S OF BUSINESS ADMINISTRATION Prepared By: Dhruv Gupta S.Y. MBA I.D. No.: GP – 069 Submitted To: Kumunidhi Ma’am Subject: International Financial Management 1

Upload: dhruvgupta1990

Post on 09-Nov-2014

107 views

Category:

Documents


1 download

TRANSCRIPT

Page 1: Indian Govenment Policy Towards Forex Markets

A

Project on

INDIAN GOVERNMENT POLICY TOWARDS FOREX MARKETS

SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENT FOR THE DEGREE OF MASTER’S OF

BUSINESS ADMINISTRATION

Prepared By:

Dhruv Gupta

S.Y. MBA

I.D. No.:

GP – 069

Submitted To:

Kumunidhi Ma’am

Subject:

International Financial Management

Date of submission:

1st Feb. 2013

INDIA’S GOVERNMENT AND ITS FOREIGN POLICY:

1

Page 2: Indian Govenment Policy Towards Forex Markets

Introduction:

The major determinants of the foreign policy of any nation are its national security

interests and its economic interests. Logically, it is these two national interests around

which should revolve the various formulations of the country’s foreign policy. Foreign

policies of nations do not function in a vacuum insulated by delusional moral and

ideological obsessions. Foreign policies perforce, have to take into account the prevailing

regional and international strategic realities with which a nation has to strike workable

equations based on one’s own existing power attributes and strategic utility to the key

global powers.

India’s foreign policies in the last eight years under the previous Bharatiya Janata Party

(BJP) led Government can be assessed as successful when measured against the above

indicators. The BJP Government’s foreign policies did make India “shine” in the

international arena, not by delusional rhetoric but by an initial display of power potential

by carrying out the nuclear weaponisation in 1998. It was a defining moment. Initial

opposition by the United States and others were soon converted into opportunities for

strategic partnerships/strategic cooperation with United States, Israel, France, UK,

Vietnam and Myanmar. For the first time, even joint naval exercises were held with

China. India’s then foreign policies were also successful in bringing significant

international pressure on Pakistan to change tack.

Foreign policies of any nation need bi-partisan support, as the country’s national interests

do not change with a change of political power. While the economic determinant could

change in terms of nuances with a change of Government, the national security

determinant cannot and should not, as the strategic perspectives that go into its

formulation have to be long range.

Regrettably, the new Indian Government, led by the Congress Party and through its flip-

flop and ill-considered statements has given indications, that it is all set to undo the

foreign policy gains of India in the last eight years.

2

Page 3: Indian Govenment Policy Towards Forex Markets

The Congress Party’s election manifesto, formulated by its present Foreign Minister

reflected the Congress Party’s traditional dislike of the United States and it also reflected

this Party’s resentment with the gains made by the BJP Government in terms of evolving

a strategic partnership with the United States. It is not the intention here to go into details

as the entire spectrum of this aspect stands analysed in great detail in this author’s SAAG

Paper No. 1002 dated 17.05.2004, entitled: “United States and India Relations Under The

New Congress Coalition Government: An Analysis.”

In generic terms, India’s new Government has three options open in relation to giving

shape to its foreign policies, and these are:

1. Non-alignment Foreign Policy.

2. Independent Foreign Policy.

The ramifications of each are discussed in the succeeding paragraphs.

Non-Alignment as Foreign Policy Precept:

Non-Alignment was Nehru’s brainchild and the Congress Party’s foreign policy fetish

thereafter. Non-Alignment also seems to be the obsessive mind-set of the Congress

Party’s present Foreign Minister and many of his genre in the Indian Foreign Service.

However, even in the heyday of Non-Alignment India was never genuinely non-aligned.

It had a marked tilt towards the former Soviet Union, Communist China and the countries

of the Communist/Socialist bloc. The key components of India’s non-alignment policies

were opposition to United States policies in all the strategic sub-systems of the world.

The danger today is that a combination of the Congress Party’s attachment of non-

alignment combined and seconded by the Communist Parties as leading members of the

Congress Coalition Government, and furthered by a Foreign Minister with an obsessive-

mindset of non-alignment could veer away India’s foreign policies in this direction.

3

Page 4: Indian Govenment Policy Towards Forex Markets

The chief manifestations of this option in terms of India’s foreign policy would be:

* United States policies in Greater Middle East, South East Asia and East Asia to be

opposed, based more on inclination than substance.

* Enhancement of India’s relations with Russia.

* Enhancement of India’s relations with China in the pursuance of the “Panch Sheel"

Concept- a concept much abused by China against India.

* Devaluation of United States-India evolving strategic partnership.

* Military-to-Military contacts with United States to be downplayed.

Proponents of this foreign policy option, fail to take into account the following

ramifications of the above manifestations:

* Non-Alignment, even in the most genuine form was applicable only in a bi-polar world.

* Non-Alignment today exists as “ fossilized remains” of Indian’s delusional foreign

policies.

* India cannot afford politically, strategically or economically to remain at odds with the

United States as the “unipolar power”.

India’s non-alignment years in terms of her foreign policy formulations and attitudes

were a national waste both strategically and economically. India’s new Congress

Government, in the interests of India’s national security and economic development

should not “inflict” this option on India.

4

Page 5: Indian Govenment Policy Towards Forex Markets

India’s Independent Foreign Policy Option:

The Congress Party keep freely mixing up and using the word “independent” with “non-

alignment”. The two, in the option of the author are entirely different. “Non-Alignment”

was a policy precept of the Third World countries, as relatively powerless countries

against the Big Powers.

An “independent foreign policy” precept connotes that a nation has such highly

developed national power attributes, that it is not susceptible to political and economic

coercion by stronger powers and also that its national power attributes endow on it the

strength to chart-out an independent foreign policy without fear of restraint from any

quarter.

India today has not reached the ‘independent foreign policy’ stage as yet due to the

following reasons:

* India’s half-a-century of mis-governance has thwarted the materalisation of its power

potential.

* Nearly half-a-century of non-alignment foreign policies has left India with no genuine

friends in the international arena.

* Decades of ineffective national security management has left India with not even

regional power capabilities in the Indian sub-continent.

An “independent foreign policy” option in its most genuine and purist form is presently

not available as an option to India. Taking “independent stands” on international issues

without the “muscle to back-up it up” does not constitute an “independent foreign policy”

It is only rhetoric.

5

Page 6: Indian Govenment Policy Towards Forex Markets

Development of Forex Markets: Indian Experience

Evolution of Indian Forex-Market

Market players in forex became active in the seventies, consequent upon the collapse of

Bretton Woods Agreement. However, India was somewhat insulated since stringent

exchange controls prevailed and banks were required to undertake only cover operations

and maintain a ‘square’ or ‘near square’ position at all times. In 1978, the RBI allowed

banks to undertake intra-day trading in foreign exchange and as a consequence, the

stipulation of maintaining `square' or `near square' position was to be complied with only

at the close of business hours each day. This perhaps marks the beginning of forex market

in India. As opportunities to make profits began to emerge, the major banks started

quoting two-way prices against the rupee as well as in cross currencies and gradually,

trading volumes began to increase. During the period, 1975-92 the exchange rate regime

in India was characterised by daily announcement by the RBI of its buying and selling

rates to Authorised Dealers (ADs) for merchant transactions. Given the then prevalent

RBI’s obligation to buy and sell unlimited amounts of the intervention currency arising

from the banks’ merchant purchases, its quotes for buying/selling effectively became the

fulcrum around which the market was operated. The RBI performed a market-clearing

role on a day-to-day basis, which naturally introduced some variability in the size of

reserves. Incidentally, certain categories of current and capital account transactions on

behalf of the Government were directly routed through the reserves account.

Recommendations of High Level Committee on Balance of Payments

The recommendations of the High Level Committee on Balance of Payments (Chairman:

Shri C. Rangarajan) provided the basic framework for policy changes in external sector,

6

Page 7: Indian Govenment Policy Towards Forex Markets

encompassing exchange rate management and, current and capital account liberalisation.

The Report indicated the transition path also. Accordingly, the Liberalised Exchange

Rate Management System involving dual exchange rate system was instituted in March

1992, no doubt, in conjunction with other measures of liberalisation in the areas of trade,

industry and foreign investment. The dual exchange rate system was essentially a

transitional stage leading to the ultimate convergence of the dual rates made effective

from March 1, 1993. This unification of exchange rates brought about the era of market

determined exchange rate regime of rupee, based on demand and supply in the forex

market. It also marks an important step in the progress towards current account

convertibility, which was finally achieved in August 1994 by accepting Article VIII of

the Articles of Agreement of the International Monetary Fund.

The appointment of a 14 member Expert Group on Foreign Exchange (Sodhani

Committee) in November 1994 was a follow up step to the above measures, for the

development of the foreign exchange market in India. The Group studied the market in

great detail and in its Report of June, 1995 came up with far-reaching recommendations

to develop, deepen and widen the forex market as also to introduce various products,

ensure risk management and enable efficiency in the forex market by removing

restrictions, introducing new products and tightening internal control and risk

management systems.

Implementation of the Recommendations of Sodhani Committee

The Sodhani Committee had made 33 recommendations and of these, 25

recommendations called for action on the part of the RBI. RBI has accepted and

7

Page 8: Indian Govenment Policy Towards Forex Markets

implemented in full or to some degree, 20 out of the 25 recommendations. In the process,

the banks have been accorded significant initiative and freedom to participate in the forex

market. These include: freedom to fix net overnight position limit and gap limits although

RBI is formally approving these limits, replacing the system of across-the board or RBI

prescribed limits; freedom to initiate trading position in the overseas markets; freedom to

borrow or invest funds in the overseas markets (up to 15 per cent of Tier I Capital unless

otherwise approved); freedom to determine the interest rates (subject to a ceiling) and

maturity period of Foreign Currency Non-Resident (FCNR) deposits (not exceeding three

years); exempting inter-bank borrowings from statutory pre-emptions (subject to

minimum statutory requirement of 3 per cent and 25 per cent in respect of Cash Reserve

Ratio (CRR) and Statutory Liquidity Ratio (SLR) for the total net liabilities respectively);

and freedom to use derivative products for asset-liability management.

Corporates also have been accorded noticeable freedom to operate in the forex market.

Thus, they are permitted to hedge anticipated exposures though this facility has been

temporarily suspended after the Asian crisis. Exchange Earners Foreign Currency

(EEFC) account eligibility has been increased and the permissible end-uses widened.

They were given freedom to cancel and rebook forward contracts, though currently due to

the Asian crisis effect, freedom to rebook cancelled contracts is suspended while rollover

is permissible. Banks can, however, offer cross-currency options on back-to-back basis.

Corporates can also avail of lower cost option strategies like range forwards and ratio

range forwards and others as long as they do not end up as net writers of options. Also

available are some degrees of freedom to manage exposures in External Commercial

Borrowings without having to approach authorities for hedging permission, and to access

swaps with rupee as one of the currencies to hedge longer term exposures.

The Committee recognised that improvements in internal controls and market strategies

go hand in hand with liberalisation and towards this end, RBI accepted and implemented

several suggestions of the Sodhani Committee. These include: revamping internal control

guidelines of the RBI to banks and making them available to corporates as well; putting

8

Page 9: Indian Govenment Policy Towards Forex Markets

in place appropriate market intervention strategies to deal with market developments;

adopting internationally accepted documentation standards; framing comprehensive risk

management guidelines for banks; adopting Basle Committee norms for computing

foreign exchange position limits and recommending capital backing for open positions;

and setting up a foreign exchange market committee to discuss market issues and suggest

solutions. Recommendation on publishing critical data on forex transactions, has been

implemented, and in fact the standards of disclosure by RBI are considered to be very

high now.

A few recommendations of the Sodhani Committee which have not been implemented

include, inducting Development Financial Institutions (DFIs) as full-fledged Authorised

Dealers (ADs), setting up a forex clearing house, legally recognising netting of

settlements, permitting corporates to undertake margin trading and setting up of off-shore

banking units in Mumbai. Let me briefly dwell on each of these issues. Induction of DFIs

as full-fledged ADs is linked to future role of development financial institutions and

indeed the approach to universal banking. Till then, their activity in the forex market can

only be incidental to what they are permitted to do as a DFI. The position on setting up of

a Forex Clearing House and the position on setting up of off-shore banking units will be

detailed in the latter part of this address. Margin trading by its very nature is considered

to be potentially speculative, and therefore, has not been seriously considered so far for

implementation.

Recommndations of Tarapore Committee

9

Page 10: Indian Govenment Policy Towards Forex Markets

Tarapore Committee on Capital Account Convertibility, 1997, had recommended a

number of measures relating to financial markets, especially forex markets. Some of the

measures undertaken in regard to forex may fall short of the indicative quantitative limits

given in the Report, but the purpose and the spirit of such measures are in line with the

recommendations of the committee. Among such various liberalisation measures

undertaken are those relating to foreign direct investment, portfolio investment,

investment in Joint Ventures/wholly owned subsidiaries abroad, project exports, opening

of Indian corporate offices abroad, raising of EEFC entitlement to 50 per cent, forfaiting,

allowing acceptance credit for exports, allowing FIIs to cover forward their exposures in

debt and part of their exposures in equity market, etc. In respect of the recommendations

of the Committee to develop financial markets also, significant progress has been made.

In the money market, as part of improving the risk management, recently, guidelines for

interest rate swaps and FRAs have been issued to facilitate hedging of interest rate risks

and orderly development of the fixed income derivatives market. Measures have also

been undertaken to further develop the Government securities market. Permission has

also been given to banks fulfilling certain criteria to import gold for domestic sale. As

will be explained later in this address, this aspect of gold policy is a major step in

bringing off-market forex transactions into forex markets by officialising import of gold.

Efforts are also underway to expedite the implementation of the announcement made in

October 1997 by RBI to permit SEBI registered Indian fund managers including Mutual

Funds to invest in overseas markets subject to SEBI guidelines.

Features of Forex Market

10

Page 11: Indian Govenment Policy Towards Forex Markets

There are several features of Indian forex market which, are briefly stated as under.

Participants

The foreign exchange market in India comprises of customers, Authorised Dealers (ADs)

in foreign exchange and Reserve Bank of India. The ADs are essentially banks authorised

by RBI to do foreign exchange business. Major public sector units, corporates and other

business entities with foreign exchange exposure, access the foreign exchange market

through the intermediation of ADs. The foreign exchange market operates from major

centres - Mumbai, Delhi, Calcutta, Chennai, Bangalore, Kochi and Ahmedabad, with

Mumbai accounting for the major portion of the transactions. Foreign Exchange Dealers

Association of India (FEDAI) plays an important role in the forex market as it sets the

ground rules for fixation of commissions and other charges and also involves itself in

matters of mutual interest of the Authorised Dealers. The customer segment is dominated

by Indian Oil Corporation and certain other large public sector units like Oil and Natural

Gas Commission, Bharat Heavy Electricals Limited, Steel Authority of India Limited,

Maruti Udyog and also Government of India (for defence and civil debt service) on the

one hand and large private sector corporates like Reliance Group, Tata Group, Larsen and

Tubro, etc., on the other. Of late, the Foreign Institutional Investors (FIIs) have emerged

as a major component in the foreign exchange market and they do account for noticeable

activity in the market.

Segments

11

Page 12: Indian Govenment Policy Towards Forex Markets

The foreign exchange market can be classified into two segments. The merchant segment

consists of the transactions put through by customers to meet their transaction needs of

acquiring/offloading foreign exchange, and inter-bank segment encompassing

transactions between banks. At present, there are over 100 ADs operating in the foreign

exchange market. The banks deal among themselves directly or through foreign exchange

brokers. The inter-bank segment of the forex market is dominated by few large Indian

banks with State Bank of India (SBI) accounting for a large portion of turnover, and a

few foreign banks with benefit of significant international experience.

Market Makers

In the inter-bank market, SBI along with a few other banks may be considered as the

market-makers, i.e., banks which are always ready to quote two-way prices both in the

spot and swap segments. The market makers are expected to make a good price with

narrow spreads both in the spot and the swap segments. The efficiency and liquidity of a

market are often gauged in terms of bid-offer spreads. Wide spreads are an indication of

an illiquid market or a one way market or a nervous condition in the market. In India, the

normal spot market quote has a spread of 0.5 to one paisa, while the swap quotes are

available at 2 to 4 paise spread. At times of volatility, the spread widens to 5 to 10 paise.

Turnover

The turnover in the Indian forex market has been increasing over the years. The average

daily gross turnover in the dollar-rupee segment of the Indian forex market (merchant

plus inter-bank) was in the vicinity of US $ 3.0 billion during 1998-99. The daily

turnover in the merchant segment of the dollar-rupee segment of foreign exchange market

was US $ 0.7 billion, while turnover in the inter-bank segment was US $ 2.3 billion.

Looking at the data from the angle of spot and forward market, the data reveals that the

average daily turnover in the spot market was around US $ 1.2 billion and in the forward

and swap market the daily turnover was US$ 1.8 billion during 1998-99.

Forward Market

12

Page 13: Indian Govenment Policy Towards Forex Markets

The forward market in our country is active up to six months where two way quotes are

available. As a result of the initiatives of the RBI, the maturity profile has since recently

elongated and there are quotes available up to one year. In India, the link between the

forward premia and interest rate differential seems to work largely through leads and

lags. Importers and exporters do influence the forward markets through availment

of/grant of credit to overseas parties. Importers can move between sight payment and 180

days usance and will do so depending on the overseas interest rate, local interest rate and

views on the future spot rate. Similarly, importers can move between rupee credit and

foreign currency credit. Also, the decision, to hedge or not to hedge exposure depending

on expectations and forward premia, itself affects the forward premia as also the spot

rate. Exporters can also delay payments or receive funds earlier, subject to conditions on

repatriation and surrender, depending upon the interest on rupee credit, the premia and

interest rate overseas. Similarly, decision to draw bills on sight/usance basis is influenced

by spot market expectations and domestic interest rates. Further, banks were allowed to

grant foreign currency loans out of FCNR (B) liabilities and this too facilitated

integration as such foreign currency demarcated loans did not have any use restriction.

The integration is also achieved through banks swapping/unswapping FCNR (B)

deposits. If the liquidity is considerable and call rates are easy, banks consider

deployment either in forex, government or money/repo market. This decision also affects

the premia. Gradually, with the opening up of the capital account, the forward premia is

getting aligned with the interest rate differential. However, the fact remains that free

movement in capital account is only a necessary condition for full development of

forward and other forex derivatives market. The sufficient condition is provided by a

deep and liquid money market with a well-defined yield curve in place. Developing a

well integrated, consistent and meaningful yield curve requires considerable market

development in terms of both volume and liquidity in various time and market segments.

No doubt, the integration between the domestic market and the overseas market operates

more often through the forward market.

Linkages among Markets and Policy Responses

13

Page 14: Indian Govenment Policy Towards Forex Markets

Since the introduction of the reform measures, broad segments of the market, viz., money

market, Government securities market, capital market, and foreign exchange market,

have exhibited some degree of integration. The markets have become inter-linked to the

extent participants can move freely from one market to another. The linkages between the

forex market and domestic markets essentially depend on the foreign currency liabilities

and assets banks can maintain and the extent and degree to which they are swapped into

rupees and vice versa. Thus, on the liabilities side, we have foreign currency borrowings

from overseas offices/correspondents, borrowings for lending to exporters, FCNR-B

deposits and EEFC/RFC deposits. These funds can be used either for raising rupee

resources through swaps or for lending in foreign currency. A significant step was taken

by the RBI when it allowed banks to lend in foreign currency to companies in India for

any productive purpose without linking to exports or import financing. This effectively

meant that companies had the choice to borrow either in foreign currency or rupees

depending on the cost, taking into account both exchange risk and interest cost. Thus,

companies can substitute rupee credit for foreign credit freely. Similarly, exporters also

have the ability to substitute rupee credit for foreign currency credit.

The integration of foreign exchange market with other markets like money market and

government securities market meant closer co-ordination of monetary and exchange rate

policy. For instance, in January 1998, when the foreign exchange market came under

severe pressure, Reserve Bank of India undertook strong monetary policy measures

leading to sharp withdrawal of liquidity and increase in short-term interest rates. The

impact of monetary management was such that by February 1998 orderly conditions were

restored in the forex market and normalcy was attained in money market. At times of

highly speculative exchange rate movements, simultaneous intervention in foreign

exchange and domestic market is called for to have an immediate strong effect on both

the exchange rate and money market conditions. Thus, to maximise the effectiveness of

the foreign exchange market intervention as a signaling device, it is also carefully co-

ordinated with monetary management.

Unique Features of Indian Forex Market

14

Page 15: Indian Govenment Policy Towards Forex Markets

Gold Policy

Liberalisation of gold policy had an indirect but, significant impact on the forex market.

The logic behind the changes in the gold policy was explained in my earlier speeches on

the subjects of capital flight and gold. The major thrust of the liberalisation process in

gold policy centred around opening up of additional channels of import, a logical

consequence of which was the reduction in differential between the international and

domestic price of gold. The price differential of gold was as high as 67 per cent in 1992

when the structural reform process was initiated; it fell to 6 per cent by the end of 1998.

The unofficial market in foreign exchange which drew its sustenance from the illegal

trade in gold went out of existence as an immediate fall out. In essence, the import of

gold which was largely on unofficial account in earlier years was officialised, and

correspondingly the foreign exchange used to finance such unofficial imports was also

officialised, mainly through enhanced flow under invisibles account.

NRI Deposits

Various deposit schemes have been designed from time to time to suit the requirements

of non-resident Indians (NRIs). Currently, we have three NRI deposit schemes, viz., Non

Resident External (NRE) account which is denominated in rupees, Non Resident Non

Repatriable (NRNR) account, which is non-repatriable rupee account except for the

interest component which is repatriable, and the Foreign Currency Non Resident (Bank)

(FCNR-B) account which is a foreign currency account. Banks have also been allowed

considerable freedom in deployment of these funds. Of interest to forex markets is the

operation of FCNR-B scheme, because banks have to bear exchange risk. Banks either

hold these deposits in foreign currency investing them abroad or lend in foreign currency

to corporates in India or swap into rupees and lend to Indian corporates in rupees. When

corporates borrow in foreign currency, there is an inflow into the market but there may be

hedging by corporates.

Public Enterprises

15

Page 16: Indian Govenment Policy Towards Forex Markets

Operations of large public sector undertakings have a significant impact especially on

spot market, and their procedures for purchase or sale of foreign currency also impact on

market sentiments. To this end, and in order to enable Public Sector Enterprises (PSEs) to

equip themselves in formulating an approach to management of foreign currency

exposure related risks, the Government of India had set up a Committee in January 1998.

The Report of the Committee explicitly brings out the approach that is appropriate for

risk management with reference to the foreign currency exposure of PSEs. PSEs with

large volume of foreign exchange exposure were also advised by the Committee to

consider setting up Dealing Room for undertaking treasury functions both for rupee and

foreign exchange which include management of rupee resources, foreign exchange

transactions and risk management. Adoption of approaches recommended would enable

the PSEs to spread their demand and supply in forex market, in a non-disruptive way to

the benefit of both the PSE concerned and functioning of forex market in India.

Off-shore Banking Units

The setting up of Off-shore banking units at this advanced stage of financial liberalisation

in our country is considered by many to be unnecessary and that the time for an offshore

banking unit has gone. In a country of our size, the issue of linkages between off-shore

sector and the domestic sector is undoubtedly an important one. We need to make a clear

distinction between the financial issues and the non-financial issues on the subject. From

the central bank's perspective, designing appropriate regulatory framework is important

and the most important issue is ensuring of a firewall between the off-shore transactions

and domestic transactions. Physical location is not relevant, especially when deposit

taking and cash transactions are not permitted in off-shore business. In fact, we do not

have a good model of real off-shore centre in a country with capital controls.

Confederation of Indian Industry (CII) with assistance from the Government of

Maharashtra is engaged in a detailed study of the various issues to make

recommendations to the RBI and the Government of India.

Clearing House

16

Page 17: Indian Govenment Policy Towards Forex Markets

The idea of establishing a Foreign Exchange Clearing House (FXCH) in India was

mooted in 1994. The Expert Group on Foreign Exchange Markets in India also

recommended introduction of foreign exchange clearing and making netting legally

enforceable. The Scheme was conceived as multilateral netting arrangement of inter-bank

forex transactions in US dollar. The membership would be open to all ADs in foreign

exchange participating in the inter-bank foreign exchange market. RBI will also be a

participating member. The net position of each bank arrived at the end of the trading day

would be settled through a Clearing Account to be maintained by RBI. It was recognised

that a substantial reduction in number of Nostro account transactions of the participating

banks would lead to economy in settlement cost and efficiency in settlement. Other

benefits include easing the process of reconciliation of Nostro accounts balances by

banks, reduction in size of credit and liquidity exposure of participating banks and hence

systemic risk, etc. The long-term objective is to establish clearing house as a separate

legal entity with risk and liquidity management features, infrastructure and operational

efficiency akin to other leading clearing systems. However, to start with, we may aim at

commencing the operation with such minimum modification to the scheme as may be

necessary. For the present, the focus areas are legal, risk and liquidity aspects and

operational infrastructure, and all these issues are under examination in the RBI.

Role of FEDAI

17

Page 18: Indian Govenment Policy Towards Forex Markets

In a regime where exchange rates were fixed and there were restrictions on outflow of

foreign exchange, the RBI encouraged the banks to constitute a self regulatory body and

lay down rules for the conduct of forex business. In order to ensure that all the banks

participated in the arrangement, the RBI placed a condition while issuing foreign

exchange licence that every licensee agree to be bound by the rules laid down by the

banker’s body – the FEDAI. FEDAI also accredited brokers through whom the banks put

through deals. There is increasing emphasis now on competition, and fixing or advising

charges by professional bodies is being viewed with disfavour and often treated as a

restrictive trading practice. It is currently argued by some that with the growth in volumes

and giant strides in telecommunication, banks may no longer need to deal through

brokers when efficient match making arrangements exist. As in some other markets, the

deals are concluded on the basis of voice broking and it is sometimes held that this often

results in conclusion of deals which are less than transparent, evidenced by instances

where deals have been called off on payment of differences. Under the circumstances,

there is perhaps a need to review several aspects, viz., compatibility of advising or

prescribing fees with pro-competition policy; role of brokers; electronic dealing vis-à-vis

voice broking; and relationship between the RBI, FEDAI and authorised dealers.

Issues that Require Further Consideration

18

Page 19: Indian Govenment Policy Towards Forex Markets

First, there are some limits on freedom accorded to banks, such as ones on

borrowing and investing overseas; ceilings on interest rates and maturities of non-

resident foreign currency deposits; and these could be reviewed at appropriate

time, with a view to liberalising them prudently.

Second, the medium-term objective of reducing cash reserve requirements to the

minimum prescribed in the statute and the longer term objective of proposing

amendments to the statute to make all the reserve requirements flexible will be

pursued, consistent with developments in fiscal and monetary conditions.

Third, the restoration of freedom to corporates to hedge anticipated exposures is

continuously under review. However, the issue of restoration of facility to rebook

cancelled contracts needs to be reviewed with caution.

Fourth, the extension of facility of forward cover to FIIs is also under continuous

review, though facilities available now are yet to be fully utilised by FIIs.

Fifth, trading in derivatives is a desirable objective, but a number of preconditions

are to be satisfied in the matter of institutional as well as regulatory arrangements.

This is a complex task, but certainly is on the agenda of reform.

Sixth, setting up a forex clearing house is on the agenda and it is essential to

design it on par with other leading clearing systems in the world.

Seventh, a number of recommendations of Tarapore Committee have been

accepted, and others are also reviewed from time to time. A view will have to be

taken on each one of them only in the context of overall liberalisation of capital

account, which in turn, depends on, among other things, progress of our financial

sector reforms and evolving international financial architecture.

Eighth, development of deep and liquid money market with a well-defined yield

curve in place is an accepted objective of RBI. The actions taken and those

contemplated to perform this hard task have already been articulated in my earlier

19

Page 20: Indian Govenment Policy Towards Forex Markets

speeches on money and debt markets, and the recent Monetary and Credit Policy

Statement of April 1999 has provided evidence of RBI's approach in this regard.

Ninth, implementation of the recommendations of the Report on Public Sector

Enterprises will facilitate the efficient management of their foreign currency risks

and also even out lumpy demand and supply situations in the forex market.

Tenth, while there is a dominant view that setting up Mumbai as an off-shore

financial centre is no longer a necessity, the views of CII, which is posing the

issue, may have to be awaited and considered seriously.

Eleventh, in any effort to develop markets, role of self regulatory bodies is

critical. The role of FEDAI in achieving greater competition, efficiency and

transparency in the forex markets needs to be reviewed on a continuous basis, so

as to keep pace with developments in technology and financial sector reforms.

Twelfth, a number of legislative changes are under contemplation, and of these

the ones relating to Foreign Exchange Management and Money Laundering are

critical to development of forex markets. Harmonisation between existing

institutions, regulations and practices, including transition path to new legislative

framework would be a significant task in the context of forex market

development.

Thirteenth, several representations have been received by Regulations Review

Authority to simplify, streamline and rationalise some of the regulatory and

reporting requirements pertinent to foreign exchange. The RRA should be taking

a final view in the matter, on the basis of expected report of group of Amicus

Curiae, within a few weeks.

Fourteenth, in the area of technology, on-line connectivity has been initiated in

respect of data transmission by market to the RBI. Once this system is fully

established, it will lead to a very prompt and effective on-line monitoring by RBI

as well as reduction in multiplicity of reporting statements. Similarly, initiatives

20

Page 21: Indian Govenment Policy Towards Forex Markets

are underway to expedite back office linkage between banks themselves and with

RBI for settlement, which will fructify once the VSAT is fully operational.

Conclusion

India’s foreign policies cannot be made captive to the delusional non-alignment

gladiators or India’s Communist Parties who have never been known for their objectivity

or to India’s minority Indian Muslims vote banks where every issue is viewed in a pan-

Islamic context.

In today’s global security environment and the international strategic realities likely to

persist for the next 50 years, India neither has the luxury nor the time to find new anchors

for her foreign policies from the fossilised remains of Nehruvian Non-Alignment or her

“presumed power potential” not concretised so far.

In the last eight years the centre-piece of India’s foreign policy has been the evolution of

a strong political and strategic partnership with the United States. United States and India

recognized the mutual convergences and imperatives and have been engaged in

establishing a substantive bi-lateral relationship.

India’s national security and economic interests dictate that this is India’s only foreign

policy option available. India’s national aspirations can best be met by formulating

India’s foreign policy inter-dependent with United States national interests and not in

opposition to it.

The medium-term objective of developing an efficient and vibrant forex market continues

to be an important priority within the overall framework of development of financial

markets. Naturally, the pace and sequencing have to be determined by both the domestic

and international developments. In particular, the unique features of Indian forex markets,

21

Page 22: Indian Govenment Policy Towards Forex Markets

legal, institutional and technological factors, and developments related to macro-

economic policies would govern the path of moving towards the medium-term objective,

without sacrificing freedom in tactical measures to respond to unforeseen circumstances

in the very short-term.

22